Credit scores are important while applying for different types of loans. Generally, lenders run a credit history verification and check the applicants’ trustworthiness to approve their claims. The higher the scores are, the lower interest rates should be paid for the loan. The higher the scores, the more attractive client you become for the lenders.
The quality of credit scores is based on a statistical analysis of data; thus, credit scores use the data in credit reports accumulated by the three major credit reporting companies: Equifax, Experian, TransUnion.
However, the lenders use different types of credit scores to assess the borrowers’ credit risk. It is said there are more than 1000 types of credit scores used under the assumption that “the past prognosticates the future.”
The FICO Credit Score
The first type of credit score is the FICO score. The term “FICO” stands for Fair Isaac Corporation “The #1 Analytic Decisioning Platform to Optimize Consumer Interactions Across all Customer Decisions.” In 1989 FICO was the first to introduce the flagship credit scoring model. 90% of the lenders use these scores, that range from 300 to 850.
- 580 and lower scores are called Poor credit.
- 580 to 669 scores are Fair credit.
- 670 to 739 are considered Good credit.
- 740 to 799 are Very good credit.
- 800 and above scores are Excellent credit.
How FICO Scores Are Made Up
35% of the whole FICO score is based on your payment history. Bankruptcies, liens, repossessions, or late payments can affect the final score.
30% of your FICO score is based on the amount you owe or so-called credit utilization. Having too much money on different accounts can affect your score negatively. Always try to keep your credit utilization ratio under 30%.
15% of the FICO score is formed based on the length of credit history and your credit accounts’ age. Thus, if you no longer use a credit account, you had better close it.
10% of your FICO score is based on the variety of loans you have. If you have a mix of loans, this can hint to the lender you are able to manage mortgages, credit cards, and installment payments.
10% of the total FICO score is made up of recent hard credit inquiries from lenders. If you had several credit card verifications during recent times, this could indicate that you are a risky borrower.
The second type of credit score is VantageScore, “The first and only tri-bureau scoring model to incorporate trended credit data and advanced machine learning.” VantageScore was created in 2006 and is owned by the three major credit agencies.
Compared with the FICO score, VantageScore utilizes four models over three credit bureaus to show the credit score based on consumer financial data.
How VantageScores Are Calculated
Trended credit data shows changes in credit behaviors over time rather than relying on static behavior. Through trended credit data, lenders gain deeper insight into borrowing and payment processes.
Machine learning is a bunch of advanced algorithms used for those clients who have sleeping credit histories, who have had no update in their credit history for more than six years.
NCAP optimization stands for National Consumer Assistance Plan, can remove specific data from consumers’ credit files, including tax liens, civil judgments, and certain medical collections information.
Each credit reporting agency has created its own method of credit score calculation and credit history verification. Here are three types of credit scores used by Equifax, TransUnion, and Experian.
Beacon (Pinnacle) Score by Equifax (also called FICO Version 5)
A Beacon score is a scoring method used while performing a hard inquiry by Equifax to decide the client’s creditworthiness. The method will show the delinquent payments, the number of open credit lines, or missed and late payments. The algorithm for this method is kept secret. However, when working with Equifax for credit score reporting, the lenders may receive full disclosure on how the score is calculated.
Empirica Score by TransUnion (also called FICO Version 4)
Empirica score is a method used by TransUnion. This form is intended to predict the borrowers’ future credit performance and comprises two score systems: Account Origination (AO) and Account Management (AM).
Empirica Account Origination provides risk assessment during the verification process and helps to refine risk-based pricing opportunities better and assess the clients with poor credit histories.
Empirica Account Management enables more profound insight into the base. Thus, it allows streamlining operational processes through effective resource allocation to provide customer satisfaction.
Fair Isaac Risk Model by Experian (also called FICO Version 2)
Like FICO versions 5 and 4, version 2’s main objective is to reveal the borrower’s trustworthiness. It is still based on the same core factors: payment history, credit use, credit mix, and age of your accounts, but the categories are calculated a little bit different according to specific algorithms.
FICO Version 8
The most widely used FICO model is version 8. This version is different from previous ones in many ways.
- FICO score of 8 is more sensitive to the credit utilization ratio. If a credit report shows a high balance close to the card’s limit, FICO 8 will be more impacted than the abovementioned score versions.
- FICO score of 8 is more forgiving. If a lender reports to the credit bureau that you have a late payment, it will result in a loss of scores with FICO score models of 2, 4, and 5. But if late payment is the only flaw, and everything else is good, FICO score of 8 justifies it.
- FICO score of 8 ignores small-dollar accounts, where the original balance is less than $100.
FICO Version 9
Nowadays, the FICO score model of 9 is becoming more and more popular among lenders. It is the newest version of FICO scores and has several advantages that make it the most predictable.
- Third-party collections no longer can hurt the FICO version of 9.
- Unpaid medical debts have a less negative impact on the FICO score of 9.
- FICO version of 9 uses rental history reports that benefit those with limited credit history.
To make more significant decisions, lenders need to use different credit scores that enable more profound insight into the credit history. That is why the models are updated periodically using new algorithms and schemes over the years.